Chapter 1 of Book V of The Wealth of Nations (available here) contains a two-page conclusion consisting of six paragraphs (WN, V.i.i.1-6), but this short recap is pure gold. Here, Adam Smith lays down two general rules, three exceptions, and an exception to the exceptions:

A. TWO GENERAL RULES

RULE #1: LOCAL PUBLIC GOODS SHOULD BE PAID FOR BY LOCALS

Public goods that benefit a local community (e.g. police and fire departments) should be paid for by the taxpayers in that local community and not by anyone else:

“Those local or provincial expences of which the benefit is local or provincial (what is laid out, for example, upon the police of a particular town or district) ought to be defrayed by a local or provincial revenue, and ought to be no burden upon the general revenue of the society. It is unjust that the whole society should contribute towards an expence of which the benefit is confined to a part of the society.” (WN, V.i.i.3; my emphasis)

RULE #2: EVERYONE SHOULD PAY THEIR FAIR SHARE OF TAXES IN ORDER TO FINANCE PUBLIC GOODS THAT BENEFIT THE SOCIETY AS A WHOLE

Public goods that benefit everyone, by contrast, should be paid by everyone. Examples of public goods that benefit everyone are national defense and the cost of “supporting the dignity of the chief magistrate” (e.g. the president, the king, the governor, etc.):

“The expence of defending the society, and that of supporting the dignity of the chief magistrate, are both laid out for the general benefit of the whole society. It is reasonable, therefore, that they should be defrayed by the general contribution of the whole society, all the different members contributing, as nearly as possible, in proportion to their respective abilities.” (WN, V.i.i.1)

B. THREE EXCEPTIONS

Next, after establishing this general rule, Smith then makes three specific exceptions: one for the administration of justice; another for roads and communication systems; and a third for education. These three types of public goods should be financed by user fees — not by the taxpayers — to the greatest extent possible:

EXCEPTION #1: ADMINISTRATION OF JUSTICE

Although everyone benefits from the rule of law, the costs of the administration of justice (e.g. the construction and maintenance of courthouses and the salaries of bailiffs, judges, clerks, etc.) should to the greatest extent possible be paid by the people who benefit the most from the court system, i.e. the litigants:

“The expence of the administration of justice, too, may, no doubt, be considered as laid out for the benefit of the whole society. There is no impropriety, therefore, in its being defrayed by the general contribution of the whole society. The persons, however, who gave occasion to this expence are those who, by their injustice in one way or another, make it necessary to seek redress or protection from the courts of justice. The persons again most immediately benefited by this expence are those whom the courts of justice either restore to their rights or maintain in their rights. The expence of the administration of justice, therefore, may very properly be defrayed by the particular contribution of one or other, or both, of those two different sets of persons, according as different occasions may require, that is, by the fees of court. It cannot be necessary to have recourse to the general contribution of the whole society, except for the conviction of those criminals who have not themselves any estate or fund sufficient for paying those fees.” (WN, V.i.i.2; my emphasis)

EXCEPTION #2: ROADS AND COMMUNICATIONS

Smith’s second exception are public goods like roads and the post office. Everyone benefits from good roads and from a reliable and fast communications system, but the costs of these public goods should be paid by user fees, e.g. tolls and stamps:

“The expence of maintaining good roads and communications is, no doubt, beneficial to the whole society, and may, therefore, without any injustice. be defrayed by the general contribution of the whole society. This expence, however, is most immediately and directly beneficial to those who travel or carry goods from one place to another, and to those who consume such goods. The turnpike tolls in England, and the duties called peages in other countries, lay it altogether upon those two different sets of people, and thereby discharge the general revenue of the society from a very considerable burden.” (WN, V.i.i.4; my emphasis)

EXCEPTION #3: PUBLIC EDUCATION

Again, although everyone benefits from a good education system, schools and sermons should be financed by the people who attend them (or by their parents in the case of children) or by private charity (e.g. alumni donations):

“The expence of the institutions for education and religious instruction is likewise, no doubt, beneficial to the whole society, and may, therefore, without injustice, be defrayed by the general contribution of the whole society. This expence, however, might perhaps with equal propriety, and even with some advantage, be defrayed altogether by those who receive the immediate benefit of such education and instruction, or by the voluntary contribution of those who think they have occasion for either the one or the other.” (WN, V.i.i.5; my emphasis)

C. THE EXCEPTION TO THE EXCEPTIONS

When user fees are insufficient to pay for the full costs of justice, roads, schools, etc., then then taxpayers as a whole must make up the difference:

“When the institutions or public works which are beneficial to the whole society either cannot be maintained altogether, or are not maintained altogether by the contribution of such particular members of the society as are most immediately benefited by them, the deficiency must in most cases be made up by the general contribution of the whole society. The general revenue of the society, over and above defraying the expence of defending the society, and of supporting the dignity of the chief magistrate, must make up for the deficiency of many particular branches of revenue….” (WN, V.i.i.6; my emphasis)

Nota bene: We will proceed to Chapter 2 of Book V of The Wealth of Nations in my next post.