The purpose of this dissertation was to analyze theoretically and test empirically the impact of individual misperceptions about the costs and benefits of public activities on the size of the public sector.

In chapters 2 and 3, the literature on misperceptions and deceptive practices in competitive markets and in the public sector was reviewed. It was demonstrated that because private and public goods possessed credence characteristics which cannot be evaluated even after a purchase, permanent misperceptions could exist about the marginal benefits of those goods. It was also argued that because of the rational ignorance of voters and the costs of information about marginal tax-costs, individual voter-taxpayers could be fooled permanently about their respective tax-prices of public goods and services, In comparison, such misperceptions of prices were considered improbable in the private sector because of the low information costs involved.

In chapter 4, the effect of permanent misperceptions of marginal costs and benefits on the level of public activities was derived by using the median voter model. For example, it was demonstrated that the permanent underestimation of marginal costs could lead to a contraction rather than an expansion of the public sector while the simultaneous underestimation of costs and benefits could promote greater public expenditures than if costs alone were misperceived.

In chapter 5, the incentives of government in promulgating permanent misperceptions by voter-taxpayers were studied. It was argued that in most circumstances, government would benefit by letting taxpayers underestimate their tax costs and overestimate their benefits permanently.

Finally, chapter 6 reviewed the empirical evidence related to the existence of fiscal misperceptions. It was concluded that while numerous investigations demonstrated that taxpayers were unaware of a variety of taxes, there were little clues suggesting that they will consistently underestimate their tax burden under particular financing institutions, Additional empirical tests presented in this study further suggested that the level of state expenditures in 1978 was relatively independent of the financing methods used by governments. The share of public debt in state revenues was the only variable found to have a statistically significant correlation with public expenditures.