Lindahl Tax - Problem With Lindahl Taxation

Problem With Lindahl Taxation

Lindahl pricing and taxation requires the knowledge of the demand functions for each individual for all private and public goods.When information about marginal benefits is available only from the individuals themselves, they tend to under report their valuation for a particular good, this gives rise to a "preference revelation problem." Each individual can lower his tax cost by under reporting his benefits derived from the public good or service. This informational problem shows that survey-based Lindahl taxation is not incentive compatible. Incentives to understate or under report one's true benefits under Lindahl taxation resemble those of a Prisoner's dilemma, and people will be inclined to under report their demands for the public goods or service.

Preference revelation mechanisms can be used to solve that problem, although none of these have been shown to completely address the problem. Among others the Vickrey–Clarke–Groves mechanism is an example of this, ensuring true values are revealed and that a public good is provided only when it should be. The allocation of cost is taken as given and the consumers will report their net benefits (benefits-cost). The public good will be provided if the sum of the net benefits of all consumers is positive. If the public good is provided side payments will be made reflecting the fact that truth telling is costly. The side payments internalize the net benefit of the public good to other players. The side payments must be financed from outside the mechanism. In reality these preference revelation mechanisms are difficult to implement as the size of the population makes it costly both in terms of money and time.