Luxury for All: A Macroeconomic Theory of Public Provision

Abstract:

Public in-kind provision of education, healthcare, or culture accounts for a large share of government spending, even though redistribution can be achieved with cash transfers and externalities addressed with subsidies. We propose a new macroeconomic theory of in-kind provision, grounded in two features: (i) these goods are luxuries, with consumption rising more than proportionally with income; and (ii) they generate externalities that depend not only on the total level of consumption but also on its distribution across households. In a tractable heterogeneous-agent model, we show that these features make direct in-kind provision welfare-improving, even when cash transfers and subsidies are available. Using household- and country-level data, we document that most publicly provided goods are luxuries and present evidence consistent with distribution-sensitive externalities. We then apply the framework to the design of fiscal consolidation, showing in a quantitative model that optimal consolidation falls primarily on goods without private substitutes, while preserving in-kind provision of goods with private substitutes. Finally, our framework yields a welfare-based valuation that reduces the measured equalizing effect of in-kind benefits in France by about one third.