Full text of DOI:10.1177/109114202238005

PUBLI CB aF cI kNh Aa uN s C/ EO RL DE VO I ER WN EW PUBLIC FINANCE?
The traditional discipline of public finance had originally been the core of political econ-
omy. Over the past three decades, however, it has been redefined by leading scholars as
the new public finance or public economics. At the same time, economics as a scholarly
discipline has experienced a precipitous decline in relevance, and this has prompted
many university administrators to abolish programs in public finance. Recent awards of
the Nobel Prize in economics went to James M. Buchanan and William Vickrey, both in-
novative professors of traditional public finance. Although not ignoring the accomplish-
ments of the new public finance, this article focuses on the traditional message of public
finance as a discipline that allows scholars to communicate with policy makers. The can-
ons of taxation and the emphasis on focusing on the social question are identified as the
main tenets of public finance proper.
OLD OR NEW PUBLIC FINANCE?
A PLEA FOR THE TRIED AND TRUE
JÜRGEN G. BACKHAUS
University of Erfurt
A plea for the tried and true makes sense only if the tested and tried
has somehowbeen subject to challenge. In fact, there is a consensus
in public finance now—even a name change in the subject matter has
occurred—that “recent developments in and future prospects for pub-
lic finance” have made the tested and tried public finance superfluous
1
or perhaps a sideline of public finance. Many other examples could be
cited, such as the appearance of the Journal of Public Economic The-
ory and scores of similar lectures. In addition, a large number of sur-
vey works have cut out classical principles, knowledge, and empirical
researchinpublicfinance, andthishas oftenbeenhailedas progress. It
is not inconceivable that forgetting acquired knowledge, the relevant
techniques, and the appropriate legislation, including its interpreta-
AUTHOR’S NOTE: This is the translation of the inaugural lecture on the occasion of assuming
the Alfried Krupp von Bohlen und Halbach-Foundation Chair in Public Finance and Fiscal Soci-
ology. The lecture was originally held at the University of Erfurt on October 12, 2001. Many
comments received after the public lecture was given were received and incorporated into the re-
vised English text.
PUBLIC FINANCE REVIEW, Vol. 30 No. 6, November 2002 612-645
DOI: 10.1177/109114202238005
©
2002 Sage Publications
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Backhaus / OLD OR NEW PUBLIC FINANCE? 613
tion, can be progress if in fact the entity around which this revolved
had always been evil. It would then have to be proposed that a less evil
entity required different theories, applications, instruments, and their
implementation. However, that effort has never been made in hailing
the progress of the newpublic finance or public economics as it tends
to be called now.
In many countries, such as in the Netherlands, public finance has
disappeared as a scholarly discipline. It has been replaced in that par-
ticular case by public economics, and the supreme auditing institution
(court of audit) recruits business economists and sociologists able to
deal with accountancy. Also, the new fields of fiscal economics and
fiscal lawhave arisen. Similarly, in Germany, even traditionally proud
departments of economics have bled out, and newdepartments are be -
ing set up that teach business economics, particularly the economics
of public business in many different variations, from budgeting to hos-
pitals. These are traditional fields in public finance. This professional-
ization of traditionally public finance disciplines can be looked at in
many different ways. My way to look at it is whether it makes sense to
replace a traditional discipline that had its purpose, its methods, its
journals, its modes of scholarly contact, and its encyclopedias and re-
place it with new developments that necessarily have to acquire talents
who have to be trained differently and have to reestablish all those in-
stitutions I just mentioned.
This article is explicitly one-sided. It is a plea. I am therefore not
discussing the newpublic finance at all because my readers will be
very well aware of it. I am also not suggesting that the old public fi-
nance always led to benign results. As a matter of fact, it was such a
thorough discipline, akin to game theory, that it lent itself to benign
and less benign results. However, the discipline has always been solid
enough to make it possible to weed out crooks. Nor am I claiming, as it
has sometimes been suggested, that traditional public finance requires
a strong and austere state. Rather, I am trying to showthat the tradi -
tional principles of public finance could lead enlightened scholars to
very benign welfare state legislation; as a matter of fact, that used to be
the very heart of it. It is true that with my very heavy emphasis on pub-
lic finance doctrine, I do create the impression that public finance is a
matter of Europe (and Japan). Here, there is a slight possibility of mis-
understanding, as the United States as a scholarly community estab-
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lished a strong public finance (mind you, not public economics) schol-
arly community as a consequence of the unfortunate policies in
Europe during the 1930s. Where the scholars reach their insights,
whether at home or in exile, there is not so much an effect on the result
of their scholarly pursuit; it rather affects the zeal with which they try
to pursue it. Hence, because America received this strong public fi-
nance tradition from the 1930s all the way through the 1970s and
reaped its benefits later on, the American community of scholars, par-
ticularly deans, should be aware of what they would lose if the whole
discipline were to be reduced to something much less significant and
even perhaps hard to apply.
With this preface, I should nowlike to enter my plea for the tried
and true. As a layman—who might, for instance, have to fund a uni-
versity through tax payments—you might ask yourself what benefit
you are doing to the community. When not least through the forceful
intervention of Professor James M. Buchanan (b.1919) at a well-
memorized occasion in Roanoke, Virginia, I was all of a sudden put
into the environment of a land-grant university, and this very aspect of
having to reach students with a particular objective was very much
communicated to me, not least by the students. A land-grant univer-
sity has three objectives—teaching, research, and extension—and the
purpose of the land-grant university is to also enhance the extension of
the scholarly work into the development of the community. Hence,
when I started to teach public finance, it became clear to me that stu-
dents wanted to have something that might have an extensive value to
their future work in the community because they did not expect to re-
main students for the rest of their lives. These gentlemen students and
southern ladies taught me that you have to address your instruction to a
decision maker, who can then translate it into decisions that affect real
people’s lives. I was very much touched by this and went back to an
approach when public finance was indeed taught that way. That is yet
another reason why I want to suggest keeping public finance as one of
the required courses, as well as keeping it as one of those disciplines
that absolutelyneedtobe fundedbytheNationalScienceFoundation.
For those who ask what the purpose of public finance can be, my
suggestion is to look at guideposts because this is a science with the
purpose of policy. Centuries ago, those who asked for such a science to
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Backhaus / OLD OR NEW PUBLIC FINANCE? 615
be established had a very precise purpose—an idea—and their spe-
cific circumstances before them, and so they conceived a vision. Let
us then develop the science from the point of viewof those who felt a
need of the science of public finance, and let us put together, in an
eclectic sense, what is needed to answer perfectly sensible questions
ofrulers thatmay notmakeperfectsenseinthecontext of our models.
Once the newchairs in public finance had been established in the
1
9th century, more than 90 chairs had been founded on the European
continent before the first chair in political economy was established at
Oxford to study the matter; the problems that had to be seen in a coher-
ent circumstantial set of events sometimes called for different solu-
tions from those that could be developed in the more benign circum-
stances of Britain, the splendid island in isolation. In Europe,
particularly where public finance was developed as a new discipline,
doctrines of teaching had to be developed that would take into account
disparate entities of statehood that still had to be ruled with sense un-
der the circumstances. A science was called for that could accommo-
date empirical evidence and scientific knowledge that was not yet gen-
erally available and certainly not generalizable. The educative
building proposed for the purpose always called for a precise descrip-
tion of the problems at hand, a survey of all the case studies that had
been done, a survey of all the policy instruments available, and a sur-
vey of all the conceivable scenarios of policy making, most of which
had typically failed. Because public finance was, at the time it was
conceived, always a science that talked to a policy ruler, pointing out
all the failed policies of the past was extremely important to accom-
plish the purpose, yet it was also important to prevent believing in the
same fallacies and committing the same errors.
We can cite as our hero the political economist Johann Heinrich
Gottlob von Justi (1717-1771), who can almost be called the proto-
type scholar of public finance under such conditions (von Justi 1760).
He would always identify a ruler, whom he would talk to, and then
gather assiduously, without being impeded, every conceivable fact
that he could find to fit it into the system—of course, he had taken this
method from Wolff (1679-1754). Now, the next step consists of find-
ing the causes for public concern’s problems; public concern identi-
fies symptoms but never causes. At least, one should find triggers for
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such concern because those might point to policy instruments. Imme-
diately, we discern hints to the attempts by Umpfenbach (1832-1907)
and Wagner (1835-1917) to find general rules in describing the work-
ings of ruleable states (Umpfenbach 1859-1860; Backhaus 1997a).
It is important to note that Wagner, in his attempt at finding laws for
a state to be governed prudently, always presumed sensible rules of
government that would prevail and prudent advisers who would help
the governors, either popularly chosen or coming in through inheri-
tance, to followthose general rules that had, historically and systemat -
ically, thus been understood scientifically. Here we have to cite first of
all Wagner’s law, which is the law of the increasing tasks of the state.
Many economists have turned this into the increasing expenditures of
the state. However, Wagner does not give any clue why that should be
the case. Rather, Wagner sawthe lawof the increasing tasks of the
state as an admonishment to the ruler to find increasing sources for
state expenditure, notably those that would not burden the subjects.
Hence, in a way, Wagner can even be called in as a witness for those ef-
forts in some countries, such as Britain, that have embarked on large-
scale privatization policies. In his law, those privatization legislations
are clearly acts of government impressing the will of a government
onto an economy to accomplish a particular economic style. Wagner’s
law, by the way, is even correct for countries that try to negate it. Those
who turn to privatization invariably turn to regulation and thereby
force the iron hand of government even more forcefully. Likewise,
those who propose to engage in privatization typically turn to such in-
struments as public investment through newfinancial instruments,
2
thereby increasing the future burden on the public purse.
The more important aspect, to which Wagner’s law should lead us,
is the reason why the state has to engage in ever more encompassing
tasks. This is shown when the state, in which the law was put to its pur-
pose, faced its most extreme challenge, that of the class struggle. Two
different notions had taken hold in the minds of leading citizens, as
well as able scholars’ minds. One was the notion of national unifica-
tion, and the other was the notion of class struggle. By political ends,
the notion of national unification prevailed, but an idea cannot be put
down by fiat. Hence, the underlying cause of the competing notion of
class struggle had to be addressed. This is where Wagner’s law gets a
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Backhaus / OLD OR NEW PUBLIC FINANCE? 617
totally different turn. Now, the state has to face the failures of the mar-
ket. Hence, all those phenomena of the market that bring about these
failures have to be properly understood. One cannot cure a failure if
one has not understood the source of the predicament. Flight from the
land, leaving not a good but at least a poor and secure life and going
into the city, had destroyed the local community. Large numbers of
people, particularly young people, went into the swelling cities, look-
ing for a better life and for circumstances that somehowwould fit their
ambitions. That they did not find. It was Bismarck’s (1815-1898) (ad-
vised and guided) ingenuity to understand this as a problem of insur-
ance. Where the markets did not care to provide insurance, the state
(guided by a preeminent investment banker by the name of Bleich-
röder [1822-1893]) had to step in. The idea of insurance for social
predicaments was new. It was also new to suggest that the new so-
cial institutions should be brought about in such a way that they were
only basic and could serve as the springboard for market-based
arrangements.
It would perhaps be wrong to say that Bismarck fully understood
the economic logic of what had been proposed to him. However, it
would be equally wrong to say that he had not understood the political
logic of what he was about to implement. Many different threads were
necessary to weave the cloth of public finance. Bismarck was fortu-
nate for having advice of the kind he did at that time. What is more im-
portant is the basic message, which Bismarck did not refuse to accept
and modern scholars in public finance do refuse to accept: that there is
such a thing as scientific public finance that can guide public policy. It
has to be put on very sound footing. Newinstitutions need to be de -
vised that make it possible to find ever more purposes for the market.
In the particular case of social policy at hand, with the uninsurable
risks of life in the ever more rapidly developing economy, impetuous
industrialization with new and threatening technologies had to be
found. The then threatening technologies of the steam engine and the
railroad, still to this very day under special legislation, filled the popu-
lace with grief and despair and had to be responded to with special pol-
icies. Today, we might laugh at this, but the fears of the population at a
particular point in time certainly inform its investment behavior—
howthey invest in stocks, bonds, real estate, and, above all, their lives.
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At the time, most of them invested in their children, many of whom
perished in World War I.
Coming up, then, with a government program to create an invest-
ment scheme for the major uninsurable risks of life was a major push
at what today would be called privatization. Because there was no in-
surer in place, the Prussian state with its (relative) majority vote
pushed it forth in the federal council, and so it happened. No under-
writing, no public tender, just a state-sponsored market-based social
insurance system that would tackle these hitherto uninsurable four
risks of life. From the point of viewof public finance, as the theory
then stood, this was absolutely new. Bismarck, who had brilliant ad-
visers, had hit upon a formula that even his political instinct could not
3
fully balance.
From today’s point of view, we should look at the four risks in de-
tail. The four risks to be insured all relate to the fact that the newly ar-
rived in the swelling cities had essentially only one asset, their ability
to work for a wage. With no own land on which to eke out at least a
subsistence, the loss of this ability to work necessarily had cata-
strophic consequences for workers and their dependents. The loss
could occur because of work-related accidents, poor health, or early
death with no provisions for dependents; inability to work due to old
age; and, of course, unemployment. Bismarck’s program covered the
first three of these risks; unemployment insurance, which came later,
covered the fourth.
Whenthenewsocialinstitutions tocover these hithertouninsurable
risks of life were to be designed, two alternative options were dis-
cussed. On one hand, one can build newsocial institutions on old insti -
tutions and open those old institutions to the newcircumstances of the
market economy. Lujo Brentano (1844-1931) wanted to build on the
old guild structure and to transform such workers guilds into institu-
tions of self-help related to the trade unions (Backhaus 1997a). They
were to perform the whole set of intricately related functions of indi-
vidual and family support. Gustav von Schmoller (1838-1917), on the
other hand, was afraid that the old institutions would not be able to
perform the newfunctions and that accumulation of risk would further
endanger those who were to be insured. He therefore pleaded for a
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Backhaus / OLD OR NEW PUBLIC FINANCE? 619
market-like actuarial insurance approach with the state as the rein-
surer of last resort. Coverage was to be limited, providing a base on
which private insurers could then build so as to provide insurance poli-
cies for those workers and craftsmen who started to accumulate
wealth through industrialization. Prince Bismarck carried out the es-
sentials of von Schmoller’s approach.
von Schmoller, however, emphasized another aspect as well. On
the occasion of his introduction as rector of the University of Berlin,
he used his inaugural lecture “On the Idea of Justice in Political Econ-
omy” (von Schmoller 1881) to point out that public policy, particu-
larly the creation of newsocial institutions, could only be successful if
these institutions were considered just by the standards of the popula-
tion for which they had been created. Justice as an empirical concept
was differently conceived of in different countries by different peo-
ples, and it was, in principle, possible to establish justice in a particular
people and apply it to the creation of newsocial institutions. By estab-
lishing the notion of justice as an empirical social scientific concept,
he distinguished himself from philosophical, theological, legal, or
other approaches to provide for a political and constitutional safe-
guard to protect the newsocial institutions.
After the crushing defeat of the German empire, with which all
these reform policies of building newsocial institutions had to be
identified, the generation of von Schmoller’s students, including
Heinrich Herkner (1856-1932) and Werner Sombart (1863-1941), set
out to deal with “the economic consequences of the peace” from the
point of viewof public finance (Sombart [1916] 1927). The frame -
work of new social institutions was actually extended, unemployment
insurance was added, but the actuarial principle fell victim to the re-
gime of reparations under which Germany operated; the formation of
newinsurance funds was impossible in viewof the demands for repa -
rations, and the old funds had long been used up in war finance. Opting
for a pay-as-you-go system to fund social security, war victims and
veterans, orphans, widows, and the retired was a fiscal necessity, not a
matter of political expediency as in the United States under President
Franklin Roosevelt (1882-1945). There, on the other side of the Atlan-
tic Ocean, Congress mistrusted the president and did not want to deal
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him a large and ever-growing fund that the executive might mishandle
for its own political ambitions.
As a consequence of the provisions contained in the Treaty of Ver-
sailles, the revenues of the great state institutions (including the rail-
roads) were no longer at the disposal of the government. Hence, the
public economy after 1919 had to function in reverse gear. Where be-
fore profits had been made through participation in the market, now
losses had to be shown. Where before insurance funds had operated
strictly according to actuarial principles, nowcross-subsidization had
to be resorted to. This system, initially a measure of despair, was in
fact an anticipation of the newera of public finance that, after Abba P.
Lerner (1903-1982), came to be known as functional finance. Lerner
(1943) drewthe conclusion from Keynes’s (1883-1946) teachings that
the public budget could be put at the disposal of economic policy, no-
tably macroeconomic policy, to develop stabilization policies with re-
spect not only to the national economies but ultimately also to the
4
global economy (Keynes 1936).
German public finance had one last intellectual peak at the end of
the 1920s, when, under the direction of Wilhelm Röpke (1899-1968),
an employment program was designed with purely fiscal instruments,
which was immediately put into effect after the stemming of the repa-
rations payments as a consequence of the Lausanne Conference in
1
932.
The successful policies, launched by the last two democratically le-
gitimized governments, bore their fruit with small delay, but the har-
vest could be reaped, initially with reluctance, by the National Social-
ist government (Backhaus 1999a). This resulted in a twin tragedy. On
one hand, reducing unemployment has to this day been credited to the
National Socialists, although these policies had been laid out by the
preceding democratic governments (Backhaus 2001b). Second, the
obvious success of the employment measures, which had been errone-
ously ascribed to the National Socialists, led to a taboo. There is no se-
rious study that looks at why these programs were actually successful.
The first fault (that of not understanding the historical circumstance)
led to the second fault, not touching the taboo area of National Social-
ist policies with respect to labor markets. Because these policies ini-
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Backhaus / OLD OR NEW PUBLIC FINANCE? 621
tially were not National Socialist, an important lesson was lost on the
profession that could have studied the theory and the measures based
on the theory well before 1936. This case shows in a particularly crass
form that public finance as a scholarly discipline is always subject to
political influence; we should have surmised as much; yet the conse-
quence is that scholars in public finance should not be allowed to pur-
sue their models without consequences. Scholarship in public finance
carries a particular political ethic and responsibility. You do not have
to agree with his solutions, but it was James M. Buchanan again who
reminded us, remorselessly, of this particular ethical responsibility of
public finance scholars.
If you introduce your topic with a historical survey, it is becoming
to leave about half a century between your historical observations and
the situation as it presents itself at present. Hence, I am not looking at
the development of public finance after the Federal Republic had been
founded. The last really interesting approach to integrate public fi-
nance and public finance administration into economic theory proba-
bly came from Freiherr von Stackelberg (1905-1946), who presented
his approach to fellowscholars during the waning days of World War II.
He was interested in the economic order after the war, as he was con-
vinced that the war had been lost (Backhaus 1996). At the time, it was
considered high treason to promulgate such thoughts, and in fact von
Stackelberg had not only thought about removing the Hitler regime,
but in all likelihood he had participated in the attempt of July 20, 1944.
He was one of those rare economic theoreticians ready to take his eco-
nomic insights and translate them into economic policy measures that
he thought to be relevant, with respect to a specific economic purpose:
In his case, he was interested in promoting competition. Instead of
having an anti-trust authority that would permit, forbid, or fine, he
proposed a rigorous tax scheme that is much more radical than com-
missioner Monti might ever conceive of; as a matter of fact, he should
not because it would render his entire commission unemployed. How-
ever, von Stackelberg’s scheme, which is different from the current
policies of the European Commission, would provide the order of the
law(Rechtsstaat) so as to allowmarkets to function. After this very
broad andgeneralsurvey, letus nowlook at our topicinmore detail.
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1.THE OLD AND TRADITIONAL
DISCIPLINE OF PUBLIC FINANCE
As we look at classical public finance—after all, this is what I am
pleading for—the best way is to start with Wolff’s general system (von
Wolff 1754), and then we can immediately proceed to Johann Hein-
rich Gottlob von Justi. In true public choice tradition, one has to look
at the background and the circumstances to understand the purpose of
the core ideas of this man to give them their proper place. Adam Smith
(1723-1790) only a little later tried to explain the causes of the wealth
of nations (Smith 1776), whereas von Justi (1760) was interested in
the core idea of the state (Grundfeste), which would explain the might
but also the welfare of the states. The might of the state consists of the
abilities of its inhabitants, what today is called human capital. Yet von
Justi was interested in not only the wealth but also the ability to create
wealth and to make it possible to enable others to create wealth.
Friedrich List (1789-1846) used the expression of productive forces.
What von Justi described as the welfare of the state (Glückseligkeit des
Staates) can only be accomplished if the citizens can be enabled to
reach such a bliss point themselves, and hence it is the purpose of the
state to create the conditions for this to happen. In the case of von Justi,
the state’s happiness is obviously greater when a larger number of
people can be made happy. This is perfectly logical. After all, he was
interested in the ability to produce and create wealth and welfare and
to be able to accumulate both.
Given the circumstances, von Justi founded public finance as a sci-
ence in the context of a state-oriented general science, with heavy em-
phasis on bookkeeping in the Cameralistic tradition. This is impor-
tant. The Venetians developed bookkeeping to make it possible for
democracy to function in a state that disposed of substantial resources,
in addition to risk-laden activities, whereas the Cameralists (who have
their name because they had access to the chambers of the prince) de-
veloped a system of thought that could be taught, which was also fitted
into administrative procedures. In a sense, this is not very different
from contemporary business economics. In business economics, it is
clear what the purpose is. The consultant talks to the chief executive
officer and the board.
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Backhaus / OLD OR NEW PUBLIC FINANCE? 623
Likewise, the Cameralist would talk to the prince and, to maximize
the bottom line, would deal with the question of how the sustainability
(Macht) and welfare (Glückseligkeit) of the state could be enhanced
and furthered. The discipline, then, had a clear function: There was the
consultant, and there was the consultee (i.e., the prince)—in any
event, an identifiable regime. It could just very well have been a repub-
lic because at the time, there were republics soliciting this advice. It is
important that the purpose is not diffuse—it is the maintenance and
sustainability of the might of the state and the welfare of the people
that goes along with it—but this is a far cry from today’s welfare eco-
nomics. Welfare economics is embedded in Cameralist economics,
but the difference is that the welfare of the people is not assumed as
something that is to be given by some elite; it is enhanced through a
conversation between the adviser and the policy maker (the prince or,
in republican circumstances, the governor). Schumpeter (1883-1950)
was right in calling the Cameralists the consultant administrators
because in a Habermas-type fashion, the adviser became part of the
analysis (Schumpeter [1912] 1934). Because the consultee had to be
convinced—and this can only be done on the basis of an analysis that
produces suggestions that make sense, and that sense had to be enough
for the consultee to be able to translate the advice into reasonable
policy—the advice could be easily measured in terms of its success as
far as the implementation was concerned. In this sense, a scholarly
discipline of public finance in the Cameralist tradition can never be
irrelevant.
With broad brushes, classical public finance can be characterized
by three points. On one hand, it is built on principles that von Wolff
(1754) originally presented in his general system of natural law. The
German term for this is Rechtsschöpfung, and this means that you find
general principles in a broad literature. Wicksell (1851-1926) did the
same thing when he derived his principle of just taxation. It was by no
means tongue-in-cheek when he presented his inquiries into the the-
ory of public finance (Finanztheoretische Untersuchungen) (Wicksell
1
869) as a series of case studies in fiscal conflicts in the Swedish king-
dom and then derived from this a general principle (Wicksell 1869,
958). He was very much in line with von Schmoller’s approach, who
1
even went further in trying to distill the idea of justice in political
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economy (Hansen 1996). The point is that a particular people live by
principles that have developed over time. These principles are not nec-
essarily generalizable principles of statehood, but they are certainly
general as far as a particular populace is concerned. From these gen-
eral principles, you can derive somewhat attenuated principles that
hold more generally over public entities that have experience with tax-
ation but that are also democratically constituted. This is an important
point to note. Modern public finance does not function for political en-
tities that have not been democratically conceived. Only functional
public finance and public economics can conceivably be applied in
those instances, but modern public finance, dealt on the traditional
principles of public finance, cannot be applied to undemocratic societ-
ies. This is important because consensus is the key word in classical
public finance. Also, classical public finance always has had a penal
code of public financial activity; in particular, Wolff mentioned con-
tributions (i.e., taxes that are imposed and for which citizens do not re-
ceive any valuable activity, deeds, or services of relevance). This is in
violation of the principle of equivalence. Hence, we should now look
at those principles.
THE PRINCIPLES
The classical principles in public finance can be differently grouped
and expressed, but taken together they all amount to the same system
of rules. Most authors, even in modern principles textbooks, stipulate
about a handful of these principles. von Justi (1760) postulated six of
them to form the normative core of public finance. He started with the
principle, which he emphasized as the most important one, of the abil-
ity of the citizen to pay a tax. Citizens must be able to assume a burden
without being compromised in their ability to enhance the welfare
(Glückseligkeit) of the state. It is obvious that this is an objective crite-
rion. Only so much can be taken by taxation that the economic process
is not impeded at all. Hence, according to von Justi, the tax should not
incite any tax resistance. We note howbig the difference is between
von Justi’s principled formulation and the current versions of the prin-
ciple of ability to pay. Instead of measuring objectively whether tax re-
sistance exists as a social phenomenon and whether it is further incited
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Backhaus / OLD OR NEW PUBLIC FINANCE? 625
through specific measures of taxation, today it is generally taught that
the ability of citizens to pay a tax depends on their income and wealth;
the principle is used as an almost self-evident argument for redistribu-
tion. And this is done, although it was established beyond any doubt
well over a century ago that redistribution in whichever direction can-
not be established as a sensible political goal of taxation by way of an
argument that meets scholarly standards (Stuart 1958).
The second principle von Justi (1760) established is that of equity
and fair proportions. In modern public economics, the principle of
equal treatment before the law, particularly before the tax authorities,
has been turned into one of equity as fairness and serves as the moral
underpinning and argument for the redistribution of life chances. An
example can be found in the public health services. Again, according
to established scientific criteria, a basis for these policies cannot be es-
tablished (Backhaus 1992).
von Justi’s (1760) third principle concerns welfare and civic liberty.
Each and every measure of the state must be shown to enhance the
welfare of the citizenry, and it must not infringe on civil liberties. Only
such measures of the state can therefore be recommended, which un-
equivocally increase the chances of the citizens to meaningfully con-
duct their affairs. Today, with respect to welfare maximization, the
much weaker Kaldor-Hicks criterion with its potential improvements
is taken as a measuring rod or yardstick of public policy, and the prob-
lem of individual liberties and areas of inalienable freedom has totally
disappeared. In most textbooks, we look in vain for an explicit discus-
5
sion of civic liberty with respect to taxation.
von Justi’s (1760) fourth principle requires each measure of the
state, notably those that entail burdens, to be established in tune with
or according to the nature of the state in question and the form of its
government. This seems nebulous, but an example may serve to clar-
ify what he means. A city-state with regular markets has different
measures of taxation at its disposal than a territorial state with a sub-
stantial subsistence economy. (Many of the successor states of the for-
mer Soviet Union or most sub-Saharan African countries fit the latter
type.) The hint contained in this principle is particularly fascinating as
it seems to be regularly ignored by the team of the World Bank. A re-
public with constitutional rule by the clergy such as the Islamic Re-
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public of the Iran obviously needs other measures than, for instance,
the city-state of Singapore; the same science of political economy and
taxation must be able to take into account the institutional and consti-
tutional circumstances and to suggest equivalent but different mea-
sures for taxation and sustainable development. However, today we
often meet the hidden assumption that more or less the same programs
can be applied to all countries alike, and the same indicators can be
used worldwide to trigger different parts of one and the same program
package.
von Justi’s (1760) fifth principle requires certainty and a broad le-
gal and constitutional basis of every state measure, particularly with
respect to taxation. Certainty of the lawin most textbooks is men -
tioned indeed, but none of the textbooks I have consulted discusses in
a systematic way how the economic models explained can be imple-
mented as measures of taxation that withstand the test of an adminis-
6
trative procedure.
von Justi’s (1760) sixth and last principle refers to the implementa-
tion of all state measures, particularly those of taxation. The tax has to
be levied in the easiest and most convenient way available from the
point of viewof the citizens. The examples showthat von Justi wanted
to minimize what today we call costs of transactions. When today we
try to establish the extent of the excess burden of state measures, nota-
bly the excess burden of taxation, those costs of transactions are regu-
larly overlooked. However, they constitute an important part of the re-
search program in fiscal sociology (Backhaus 2001a).
CONSENSUS
All six principles taken together showclearly that von Justi tried to
put together entire packages of public measures that the prince could
successfully suggest to the general estates, the traditional feudal par-
liament without which no taxation could be passed. Everything that
constituted an additional burden had to be agreed to by these assem-
blies of lords. We see clearly the same principle of just taxation, which
Wicksell (1869) established as the result of his empirical studies on
the fiscal history of the Swedish kingdom. It was this principle of con-
sensus (not unanimity) that James M. Buchanan put at the center of his
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Backhaus / OLD OR NEW PUBLIC FINANCE? 627
reorientation of public finance, which he based on the classical Italian
texts and, notably, the work of Wicksell.
von Justi (1760) postulated the principle more generally for eco-
nomic policy, not just public finance. Contrary to the Kaldor-Hicks
criterion, in von Justi’s formulation, the implication is clearly that the
state as an entrepreneur can find “newcombinations” (Schumpeter
1
934)—newcombinations that he suggests to the citizens and that
they will gladly appreciate if they are advantageous from their point of
view. Hence, the state is not seen as a Leviathan but rather as an entre-
preneur that acts in the interests of his citizens. Is this a realistic per-
spective? From the point of viewof economic history, we can state as a
matter of fact that even in 1918 in the German empire, which was a
confederation of states, there were some principalities that raised no
taxes at all yet at the same time offered substantial public works and
services that were all supported with the profits of market-based entre-
preneurial operations. Even the Prussian state received about half of
its revenues from its state enterprises. During the early years of the
German Federal Republic, public enterprises played a substantial
role, notably in reconstruction. Once these tasks had been largely ac-
complished, theytendedtobe privatized, suchas theVWcorporation.
From the point of viewof the principle of consensus, entrepreneur-
ial activity of the state, if the state is not granted any privileges, is par-
ticularly significant because the state as an entrepreneur does not
claim anything from its citizens that these citizens do not want to give
voluntarily. When there is no coercion and when everything is done
out of free will, there is obviously no resistance and no economic loss
due to this resistance; hence, there cannot be an excess burden on the
7
basis of those measures that von Justi (1760) had in mind.
By putting von Justi into the proper context within the history of
thought in public finance, we can arrive at a conclusion that is, from
the point of viewof economic policy, rather unusual. The state as an
entrepreneur can very well be seen as an integral part of the market
economy, and this also can be the case in this age of globalization.
Likewise, given recent controversy and the activities of commissioner
Monti, state enterprises can claim their proper place in the common
markets of the European Union, as it had been provided for in the
Treaty of Rome. Yet the condition must always be that state enter-
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JAGD
R
F
R
O
F
R
S
C
H
prises are given no preference over others, whether this competition
already exists or whether it is only by contention. This argument for
state entrepreneurship follows consensus-based welfare economics
not just from the interest of the treasurer, however legitimate these in-
terests might be.
THE PROHIBITION OF CONTRIBUTIONS
The third critical element of classical public finance, on the face of
it, looks so utopian that I have left it for the conclusion. von Wolff
(1754) was explicit in deriving the prohibition of contributions from
natural law; this means that all those levies for which citizens do not
receive an equivalent are illegal and void. If citizens have to choose be-
tween the demands of a state and those of a criminal organization, and
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Backhaus / OLD OR NEW PUBLIC FINANCE? 629
they decide on the latter (Nerré 2001) because they expect better pro-
tection from the gang than from the state, then precisely that case has
occurred against which von Wolff had adamantly warned. von Justi
(1760) repeated this warning in his set of basic principles. How should
a state be fiscally provided for if it cannot levy any taxes for which the
citizens receive nothing in return?
The answer to this question is by no means trivial, but there are nu-
merous historical examples. We can turn to the populist economist
Henry George (1839-1897) or the Nobel Prize winner William Vick-
rey (1914-1996), who both in their different ways have argued for
incentive-compatible forms of taxation (George 1888; Vickrey 1994).
A somewhat more exotic example, which is not very well known, may
drive home the point more forcefully. In 1898, the later admiralty
council Dr. Wilhelm Schrameier (1859-1926) was suddenly con-
fronted with the task of designing a constitution for the protectorate of
Xingdao that should have allowed for (1) the protectorate to serve as a
base to access the Chinese internal market; (2) the building of an infra-
structure, an administration, and public health services, including a
university; and (3) a plan for the entire protectorate to be handed over
to China after the end of a lease of 99 years. The task was one of sus-
tainable development. He therefore divided the time horizon in three
equal parts of 33 years and designed a city map and zoning for the
practically uninhabited place, which, from the point of view of geog-
raphy and maritime demands, was a particularly favorable bay. The
city map with the zoning system allowed for an assessment of the land
rents. Public areas remained untaxed. By taxing away the land rent yet
leaving all improvements tax free (i.e., all the buildings and other in-
frastructure investments could bear their fruits without any taxes lev-
ied on them), Schrameier was able to lay the foundations of what
shortly thereafter was to be called the pearl of East Asia. In 1914, the
pearl was considered so valuable that the Japanese invaded China and
took the protectorate from the mainland as it had defenses only toward
the sea. (Because it was to be turned over to the Chinese, there was no
attempt at fortifying it against the mainland.) Not a single tax penny
had been allocated in the imperial German household for the civilian
construction of the city, which the parliament would probably never
have approved anyway. Today, the city boasts several million inhabit-
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ants, yet the buildings constructed under Schrameier’s tax scheme,
seemingly built for eternity, have even survived the tempests of the
Cultural Revolution (Backhaus 1997b).
Much less exotic examples can be found in the numerous projects
that William Vickrey had theoretically devised and practically pro-
posed, which are designed in such a way that politicians, aiming at re-
election, cansuccessfullypursueandputintopractice(Vickrey1994).
A BASIC POINT ON ECONOMICS
Economics is the science of choices. Citizens, out of their free will,
make choices, and they do not behave like the elegant figures in Hein-
rich von Kleist’s puppet theater. For economic and fiscal policy, this
implies that citizens have to be presented with alternatives from which
they can meaningfully choose. They have to be presented with choices
that they gladly opt for. This article will close with a brief discussion
of three such options.
2
.THE PHENOMENON OF FASHIONS IN
PUBLIC FINANCE THEORY AND POLITICS
Fritz Neumark (1900-1991), for a long time the senior of public fi-
nance in Germany and longtime editor of its foremost journal,
Finanzarchiv, was one of those budgetary experts who helped in trans-
lating the deficit-based reemployment policies of 1932 into budgetary
measures. In 1933, he was forced to emigrate from Germany and
moved to Turkey, which had extended an invitation to German schol-
ars to build the newuniversity at the Bosporus, the Marmara Univer -
sity. He also helped bring about fiscal reforms there; even in the 1980s,
he enjoyed a stupendous public reputation in Turkey. This realist, who
emphasized practical results and applications in a much-noted essay
in the international social science journal Kyklos, pointed to a problem
that can plague a discipline that, by its purpose and function, is close to
political decision taking.
He talked of the fashions in public finance politics that can sway
and infect an entire scholarly discipline (Neumark 1975). In many
parts of life, little may be objected to the phenomenon of fashions. We
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Backhaus / OLD OR NEW PUBLIC FINANCE? 631
are happily surprised when, due to the caprices of fashion, people we
have grown used to suddenly surprise us by appearing in different cos-
tumes; small disadvantages may be adroitly compensated, and as we
grow older we are reminded of happy times when the fashion cycle re-
peats itself. Fashions do not only make life more varied and interest-
ing, butdue to thecycle in whichthey tendto appear, they even createa
semblance of continuity.
In politics, however, fashions do not necessarily meet with positive
reactions. When, confronted by a budgetary crisis, the minister of fi-
nance wants to increase the tobacco excise, we are reminded of
Popitz’s law, and the appearance has an haut goût of déjà vu. One can-
not suppress a certain distaste, and the cartoonist makes the point
clearly. (Headline: “Increase in Tobacco Excise to Bolster Security
Expenditures.”) The recurring topic has a very long history. During
the Seven Years War, which almost led to the bankruptcy of the Prus-
sian state, Frederick II (1717-1786) had to increase the coffee excise.
A poster shown in the streets of Berlin depicted the king as an old
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woman with long fingers trying to snatch away coffee beans from a
coffee grinder. One day, people gathered in the street to look at the
poster as the king rode by. Embarrassed, the citizens gave way, but the
king is supposed to have said, “Put the poster higher up, so it can be
better seen.”
Today, the classical excise tax is sometimes called an eco-tax. Al-
though it is well known that an eco-tax can only be effective inasmuch
as it is ineffective as an excise in raising revenues, only taxes without
revenues can be effective eco-taxes. And when, on top of this, the clas-
sical excise is even hailed as a measure of labor market policy (which
is to yield the double dividend of an improvement in the environment
coupled with a positive employment effect) and is seriously suggested
in political discourse, citizens have a right to turn away from tradi-
tional politicians and claim to be tired of politics (Backhaus 1998a). It
is easy to showthat the double dividend rests on a very specific model-
ing approach with very specific assumptions that cannot be reaped in
present-day Germany with its present-day institutions.
From the point of viewof public finance, you have to ask whether,
instead of turning to models, it would not be better to use a classical
form of legitimizing taxes. I am thinking of the agreement of the taxed.
Even if the expert in public finance in the council of economic advis-
ers is willing to go along with this political game, the simple citizen
whohastopaythe eco-tax at thegas stationknows fullwellthat theso-
called eco-tax is nothing but a classical excise tax. Citizens may not
knowthe term excise tax, but they knowhowit works because it has al -
ready been around for several centuries. With good reasons, von Wolff
(1754) criticized the excise tax from the point of viewof natural law
principles; today, we can put forth essentially the same argument by
pointing to the welfare loss that excise taxes cause.
In fact, fashion cycles in public finance have a long tradition. Since
Teutophilos (ca. 1685) proffered the excise tax as a recently discov-
ered nugget hole, ministers of finance have rediscovered the nugget
hole with ever-new names but always the same principles. Most of the
eco-tax and the tobacco tax are classical excises. Another recent
comeback of an old nugget hole are the so-called privatization wind-
falls that some states such as Bavaria and Baden-Wuerttemberg have
recently earned and disposed of. Selling mines, stocks in public utili-
ties, or real estate can hardly be hailed as a profit-making activity. We
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Backhaus / OLD OR NEW PUBLIC FINANCE? 633
are talking nowabout pure liquidations, which are extraordinary state
revenues that should not be used, according to classical principles, for
the ordinary budget but only for the extraordinary budget for either re-
ducing the public debt or infrastructure investments. In fact, what is
hailed here as an extraordinary operation of privatization should be an
ordinary restructuring procedure. For every public enterprise that can-
not earn profits in excess of the current bond rate, the assets should be
disposed of with the possible side effect that a private entrepreneur
might do better.
In this vein, privatizations had already been suggested by von Cölln
(1753-1804), who in this way interpreted Adam Smith’s teachings
against the then current Prussian fiscal policies. The state should re-
treat from public enterprise and leave it to the private initiative. In this
way, the first large wave of privatizations was initiated after Napoléon
(1769-1821) had both politically and economically weakened Prus-
sia, and newideas were much in demand. The state bankruptcy as a
consequence of the Treaty of Tilsit did not happen, however, because
the Prussian sea trade corporation skillfully managed the substantial
and unfunded Prussian public debt, notably in the London market. To
avoid an open bankruptcy of Prussia, the extent of the debt had been
kept secret, and after about a generation of skillful management, new
issue and repurchase, and the launching and later sale of newpublic
enterprises (notably in newtechnologies), the debt had been totally
paid off. The sea trading corporation even built positive assets. It
needs to be emphasized that these practices were totally at variance
with the views of the leading theorists of the time. Wilhelm von
Humboldt (1767-1835), who put his stamp on the new Prussian state,
was interested in defining the limits to which the state could be effec-
tive. It cannot be denied that this basic approach can also lead to ideo-
logically caused mistakes when effective and beneficial state activi-
8
ties are dismissed on a priori grounds.
Sometimes intellectual fashions can be used to create newareas of
freedom for scholarship. This is, of course, particularly important
when scholarship is under siege. After Hans Grimm (1875-1959) pub-
lished his book People Without Space (Volk ohne Raum) (Grimm
1
926), a book written in Southwest Africa that argued for the need of
colonization there, a whole new scholarly discipline dealing with
space and location developed and received politically motivated sup-
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port in the 1930s. Economists recalled the roots of mathematical eco-
nomics, notably von Thünen’s (1783-1850) location theory (von
Thünen 1842), and the Institute of World Economics with its research
emphasis on space theory (i.e., location theory) created an area of free
and unfettered research, where von Lösch (1906-1945), who had re-
turned homesick from Harvard, could work out his path-breaking con-
tributions.
CLASSICAL PRINCIPLES AND MODERN EXPERIENCE
Having first discussed the classical principles with respect to gov-
ernment, but notably with respect to taxation, it now makes sense to
look at 300 years of experience and to see howthey stand up in the
light of three centuries. After all, the principles had not just been re-
vealed; rather, von Wolff had carefully distilled them from natural law,
and von Justi had transposed them into a system of public finance that
could be taught. The method of derivation was, however, not pure de-
duction as it had been before, when Luther (1483-1546) dismissingly
said about the natural law, “de iure naturae multa fabulamor” (Luther
1
883). In von Wolff’s case, there is not just the construed, the hypo-
thetical, the possible, and the derived; rather, the whole work tries to
integrate all those empirical facts of lawthat the author could put his
hands on. It is the concreteness and empirical validity of his explica-
tions that explains why von Wolff, after a quarter of a millennium even
today, is an important source at the tribunal at The Hague.
The six principles. From an empirical point of view, the first princi-
ple seems to be almost self-evident. A measure of public finance must
be feasible; otherwise, it cannot fulfill a function except in talk shows.
The limits of feasibility, however, have been drastically extended as a
consequence of progress in making administrative procedures more
efficient, in developing newinstruments in every market in which the
government plays a role, and in terms of the international interconnec-
tedness where new techniques (e.g., market instruments) can be
pushed to their great effect. In fact, public finance in administration is
hardly up to the task of modern government. The procedures that are
necessary to followthe rule of lawrarely have been upgraded and are
often cumbersome. We can see that the first principle, which Stiglitz
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Backhaus / OLD OR NEW PUBLIC FINANCE? 635
(b.1942) pointedly put in last place from the point of viewof modern
financial practice, is particularly important because it requires the
public finance institutions to upgrade their practices to modern possi-
bilities and the modern state of the art (Stiglitz 2000). This refers to the
Internal Revenue Service, but it also refers to the cooperation between
certified public accountants and the revenue service, as well as the ser-
vices of controllers, fiscal courts, courts of audit, specialized colleges
where civil servants are being trained, and, to that extent, also the uni-
versities.
The second principle—that of equality—certainly found a solid
position in occidental constitutions, especially after the French revo-
lution with its call for liberty, equality, and fraternity. Far beyond its
original area of application, the principle is nowuniversally being ap -
plied, even to an extent inside the family. The connected principle of
proportionality also belongs to the solid core of principles in Euro-
pean public administration and constitutional law(Backhaus 2001b).
We cannot think of modern open societies that are market based with-
out these twin principles being in force. The market is a system of
communication that can only work on the principle of equality of ac-
cess, and a legal system that is formed around the market has to incor-
porate the same principle of equality of access (to the court, to admin-
istrative procedures, and the like). The classical principle has been
vindicated, we might say, by the logic of the market.
Looking in hindsight, the third principle also had an unbelievable
predictive power. The warranty of individual liberty is now univer-
sally taken for granted, and trying to insist on it leads to the resistance
of many a powerful apparatus. Yet the connection between individual
civil liberties and the activities of the state in the individual spheres of
income and wealth is not necessarily well understood—notably on
both sides of the Atlantic and especially after the September 11, 2001,
terrorist attacks on the World Trade Center and the Pentagon. Hence,
when the state exceeds its limits and violates individual liberties, even
in the pursuit of noble purposes, the necessary welfare loss may be
large but is never fully accounted for. Another example taken from re-
cent German history may illustrate the point. The parties negotiating
the reunification treaty always claimed that those properties expropri-
ated by the Russian military administration immediately after 1945
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(
largely real estate and industrial property, where much of the real
estate concerns agricultural and forestry property) could not be
restituted because of objections from the former Soviet Union, then
guaranteeing power. This is not just a matter of whether the families
expropriated under archaic circumstances after 1945 are nowbeing
prevented from disposing of their property and thus have their individ-
ual freedoms violated. The negative economic consequences go much
beyond this because the old and legitimate owners can no longer build
on the specific bond that they have with their inherited property, they
cannot bring the long lines of credit that they have built up in the West
back to the former properties, and they cannot bring back the know-
howthey have taken to the West. In addition, the newtechnologies and
goodwill accumulated in the West are withheld from the orphaned fac-
tories, farms, and other ventures. This is particularly true after mid-
1
990s because the large orphanage, the German Treuhand, has fin-
ished its task offindingnewparents. Theresultof this is easily grasped
by any visitor in the newfederal states, where inner-city areas remain
unused; large, impressive buildings decay; and the state forestry ser-
vices run large deficits, despite the fact that returning the forests to
their legitimate owner would not only relieve the state of a burden but
would also make sense from a business and ecological point of view
(Backhaus 2002). Hence, we note that the principle of protecting indi-
vidual liberty has much more complex indications from a purely eco-
nomic point of viewthan generally meets the eye.
The fourth principle likewise remains fresh and modern. Every
measure of the state has to be in synchrony with its structure because
otherwise there may be friction. In the European Union, we have
member states with largely differing constitutional structures. Any
common initiative cannot be readily legislated; it can only be formu-
lated in principle, and then the principles need to be translated into
measures commensurate with the structure, the legal institutions, and
history of the specific member state in question. This means that, in
principle, the commission cannot regulate directly, nor can the council
of ministers. Everything has to be implemented, and there is plenty of
room for disagreement about the quality, intensity, and form of imple-
mentation, as well as about the European zeal with which it is pursued
in any particular member state. Here, traditional principles of public
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Backhaus / OLD OR NEW PUBLIC FINANCE? 637
finance can be readily applied and generalized into more encompass-
ing principles of harmonization. The newsubdiscipline of constitu -
tional public finance can help in showing how different legal princi-
ples and different legal institutions, given the same purpose as agreed
on a European level, can be put into effect in an efficient and expedi-
tious manner (Backhaus 1998b).
The principle of legal certainty, the fifth principle, likewise has
been validated from an economic point of view. Its importance ex-
tends by far beyond the sphere of public finance proper. When legal
certainty is lacking, economic progress cannot take place. One only
has to look at those countries undergoing processes of economic tran-
sition: In those states that succeed in building up reliable legal institu-
tions and guaranteeing the rule of law(Rechtsstaat), not only eco -
nomic life but also civic life is developing, sometimes in large leaps.
On the other hand, when the rule of law cannot be established, we see
retrogression at sometimes more primitive stages of development
(e.g., a reversion to an agrarian subsistence economy). The rule of law
is also a matter of competition among legal regimes. In the United
States, the share in the social product that is used for the legal sector is
almost twice as high as what is needed in Western European states,
and it would be hard to suggest that the degree of legal certainty and
the quality of legal services are commensurately higher in the United
States than they are in, for instance, France. Future research will have
to focus on isolating those transactions costs that are responsible for
these substantial differences. Those legal systems that can render ser-
vices at lower cost will have to prevail. This type of research will re-
quire cooperation between economists working in the areas of public
finance, law, and economics and lawyers working in comparative law
and empirical legal research.
Finally, the principle of efficiency, the sixth principle, is nowquite
generally a principle of social organization that is generally accepted.
However, this acceptance does not mean that it is widely realized. Al-
though those corporations that are market oriented have to develop
forms of organization that compete with each other (otherwise, the
corporations cannot survive), this is not the case for the organizational
forms of public administrations and enterprises, and this has a peculiar
result: Because X-inefficiency is not eliminated during processes of
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organizational evolution, it tends to accumulate in public organiza-
tions, and there is increasingly a pent-up need for organizational re-
form that cannot find a ready release in decisive political and organi-
zational action. Future research will have to focus on the development
of processes that, in a self-regulating way, allow for public organiza-
tions to reform themselves in much the same way as private organiza-
tions do.
The social question. The second big and modern area of public fi-
nance, the social question, has undergone a very similar intellectual
development, as have the classical principles or canons of taxation.
Originally derived from the postulates of natural lawbut elaborated in
ascholarlyfashionover thecenturies, theyhavedevelopedtheir politi-
cal function and received an empirical underpinning that has turned
what was originally a legal and political postulate into a research pro-
gram with its constitutive scholarly disciplines and respective social
institutions that correspond to the research program. When Prince
Bismarck posed the social question, economists at the German Asso-
ciation for Social Policy organized their research projects to come up
with reasonable answers, which resulted in the new social institutions
and in a further elaboration of what could be expected from the state.
In fact, the functions or tasks of government increased manifold (see
von Schmoller 1978, particularly bk. II, chap. 8).
Of course, even in preindustrial times, the state had a social func-
tion, and many institutions such as municipal foundations still exist in
European cities, which have continued their work since medieval
times. However, the social question Bismarck referred to could not be
dealt with by means of those traditional institutions. The new state was
in danger of falling apart not because of external aggression but rather
because of the conflict that Marx (1818-1883) described as class
struggle. A growing proletariat that reproduced itself according to the
iron lawof wa ges wa s pitted against an upper class that became
smaller and smaller in proportion yet accumulated more and more of
the nation’s wealth. It was the great achievement of the creators of the
newsocial institutions to reverse this process. It has to be kept in mind
that the newsocial institutions did not just evolve. They were the prod -
uct of theoretical work, empirical research, and political action, all
three working hand in hand. In this way, the life chances of the work-
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Backhaus / OLD OR NEW PUBLIC FINANCE? 639
ing class and the small middle class were much improved as a conse-
quence of conscientious social policy based on economic research.
Today, we are confronted with a very similar problem—not on a na-
tional but rather on a global plane. Neither the European Union nor the
United States can close its borders, but it is equally impossible for
them to open their own social institutions to a sustained stream of im-
migrants. It is equally impossible to lock those immigrants out from
social services because that would create an underclass and break up
the communities. The social question, hence, is back on the political
agenda, and again it is the task of the social scientist to provide an an-
swer in the way described above.
The challenge posed by the open economies. Globalization, how-
ever, poses newquestions and offers newchallenges in the very re -
search area of public finance. I am referring to public goods or social
goods, as Musgrave (b.1910) prefers to call them. These goods meet
two criteria. On one hand, consumption of the same good by one con-
sumer or one group of consumers does not rival the consumption of
the same good of some other consumer or group of consumers. Public
goods are nonrivalrous. Second, they also have the characteristic that
nobodycanbeexcludedfromconsuming suchagood. Thismeans that
economists have to come up with a response in terms of organizational
design: Those who cannot be excluded from consumption will be hard
to persuade to pay for the production. In this sense, the public finance
theorist is challenged to come up with schemes that allow for the par-
ticipation of every beneficiary in both production and consumption.
This can be done by making consumption in the future conditional on
assuming a share of production in the present. Or one can take a com-
plementary private good and use it for financing the production of the
public good, or else one can structure the groups of consumers to orga-
nize their self-interest and make it the agent of efficient production.
Creative organizational design is needed because the traditional
form of organizing production by national states, provinces, or local
entities will no longer suffice in the globalized economy. Increasingly,
these public goods extend over entire parts of the world, and often they
require substantial resources to be provided. We can think, for exam-
ple, of the means of modern communication, including the transfer of
the written word, the transfer of other data, and the modern traffic of
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PUBLIC FINANCE REVIEW
people and commodities. We can also think of ecological issues, cli-
mate change, the diversity of species, the protection against specific
and lethal forms of radiation, and the like. And finally, the most impor-
tant factor of production, if it is sufficiently available, has elements of
a public good. I am referring to human capital. Human capital is cur-
rently produced in different states to very different degrees and by
very different groups; in fact, the production of human capital is con-
centrated in only very fewregions of the world—entire subcontinents
contribute little or nothing to the production of human capital. How-
ever, we can recall von Justi and his felicitous citizens. The more edu-
cated citizens in the world are, the happier they will be because with
the improvement in their education, we also have a concomitant im-
provement in their health state and their life expectancies. Well-edu-
cated and happy citizens produce more than they can consume and
thereby shoulder a larger share in the costs of providing global public
goods.
The tried and true—two theoretical arguments. One could mistak-
enly think that my plea for the tried and true is just the expression of a
deep-seated anti-modern conservatism. The opposite would be closer
to the truth. There are two theoretical arguments for the tried and true.
The first has been proposed by Friedrich August von Hayek (1899-
1
992), the Nobel Prize winner. He offered an evolutionary approach to
social theory, which looks at institutions from the point of view of how
they can deal with information. Each institution such as a family, a
group, a corporation, an administration, or an institute such as the civil
code or a tax code all absorb information over the course of time, in-
formation that results from the vicissitudes in the circumstances with
which a particular institution is confronted. Organizations confronted
with these vicissitudes develop strategies for survival. This is also true
for social institutions, such as the German Civil Code (Backhaus
1
999b), which is so durable because it has survived the most diverse
environments and provided answers to very different legal and social
conflicts. The social institution involves, of course, not just the civil
code but all those systematically working with it—the commentators,
the professors, the lawyers, the attorneys, and the general public as its
user. These conflicts first posed themselves during the Empire and its
sometimes stormy development, which also included deep crises; the
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Backhaus / OLD OR NEW PUBLIC FINANCE? 641
war economy; the conditions posed by the revolution of 1918; the pe-
riodofthedemocratic governmentwithsuchspecificinfluences as oc-
cupation, coup d’état, hyperinflation, and mass unemployment, in-
cluding a deep economic crisis; the national socialist dictatorship; the
second war economy; the postwar economy without a currency; the
reconstruction of the German Federal Republic; and the reconstruc-
tion of the Democratic Republic—all still with the same civil code.
From this follows that this particular social institution, the civil code,
is attractive to countries in transition because while adopting it, they
adopt an entire legal tradition that is necessary for a market economy
and provides an interesting alternative to their own limited legal tradi-
tion because the entire process of learning embedded in the code and
its commentaries can be taken over without having to repeat and incur
the costs of learning.
The same is true for tax codes and entire tax systems. Intricate is-
sues of applying tax codes have to be resolved in such a way that both
parties, the revenue service and the taxee, can somehowlive with it.
The solutions become the common knowledge of public accountants
and can be taught in tax courses; they become part of business life. Ev-
ery basic change implies that this entire process is to start off afresh,
and a newequilibrium has to be found. In this sense, the advantages
from change must be very clear, and it must always be shown that the
advantage from change is larger than the loss of experience that has to
be rebuilt after the change. These costs of change, as a rule, are hard to
ascertain and therefore tend to be underestimated.
A different issue is specific to the results of research in the social
sciences. Leland B. Yeager (b.1924) has pointed to this issue (Yeager
1
981). In the natural sciences, the result of research has a natural coun-
terpart in technology. The technological achievements can be repro-
duced and, in this sense, become part of the common cultural heritage;
they cannot be forgotten. You can always reconstruct a machine, as
long as you have a prototype or at least the blueprint. Social institu-
tions, on the other hand, particularly if they are based on theory (e.g.,
the International Monetary Fund, which is based on the theoretical
work of John Maynard Keynes [1883-1946]), can only be sensibly
steered and used if that theoretical foundation is present as common
knowledge. In this sense, we need to build our work on those old theo-
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