Prepared by: FERNANDO QUIJANO, YVONN QUIJANO, KYLE THIEL & APARNA SUBRAMANIAN 1 Why Study Public...

Prepared by:FERNANDO QUIJANO, YVONN QUIJANO,KYLE THIEL & APARNA SUBRAMANIAN

1Why Study Public Finance?

© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber

Public Finance and Public Policy, 2/e

Jonathan Gruber

Econ 344 Public Finance

Chapter 1 - Introduction

Public Finance

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Public Finance Defined

Public finance is about the taxing and spending activities of the government.

Also known as “public sector economics” or “public economics.”Focus is on microeconomic functions of government – polices

that affect overall unemployment or price levels are left for macroeconomics.

Scope of public finance unclear – government has role in many activities, but focus will be on taxes and spending.

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Public Finance and Ideology

How should a government function in an economic sphere?

Mechanistic view – government is a contrivance created by individuals to better achieve their individual goals. Individual, not group, is at center stage.This is the viewpoint taken in the textbook.

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The Legal Framework

Federal governmentFederal Constitutional provisions

Article 1, Section 8Article 1, Section 916th Amendment5th Amendment

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The Legal Framework

State governmentsFederal constitutional provisions

10th amendment

The State constitutions

Local governmentsDerive power to tax and spend from the StatesFiscal independence of local governments

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Why Study Public Finance?

1.3 Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education

1.2 Why Study Public Finance? Facts on Government in the United States and Around the World

1.1 The Four Questions of Public Finance

Controversies about the proper role of the government raise the fundamental questions addressed by the branch of economics known as public finance.

The goal of public finance is to understand the proper role of the government in the economy.

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The Four Questions of Public Finance1 . 1

public finance The study ofthe role of the government inthe economy.

Four questions of public finance

When should the government intervene in the economy? How might the government intervene? What is the effect of those interventions on economic outcomes? Why do governments choose to intervene in the way that they do?

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market failure Problem thatcauses the market economy to deliver an outcome that does not maximize efficiency.

When Should the Government Intervene in the Economy?

Market Failures

1 . 1The Four Questions of Public Finance

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The Measles Epidemic of 1989–1991

A P P L I C A T I O N

After the measles vaccine was introduced in 1963, measles cases had become relatively rare in the U.S. by the 1980s. Over the period from 1989 to 1991, however, there was a huge resurgence in measles.

It is clear that this outbreak resulted from very low immunization rates among disadvantaged inner-city youths.

These unimmunized children were imposing a negative externality on other children who had received their immunizations but for whom immunization may have worn off.

The federal government responded to this health crisis in the early 1990s:

The government publicly encouraged parents to get their children immunized.

The government also paid for the vaccines for low-income families.

The result was impressive. Immunization rates, which had never been above 70% before the epidemic, rose to 90% by 1995. Government intervention clearly reduced this negative externality.

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redistribution The shifting ofresources from some groups insociety to others.

When Should the Government Intervene in the Economy?

Redistribution


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How Might the Government Intervene?

Tax or Subsidize Private Sale or Purchase

1 . 1

One way that the government can try to address failures in the private market is to use the price mechanism, whereby government policy is used to change the price of a good in one of two ways:

1. Through taxes, which raise the price for private sales or purchases of goods that are overproduced, or

2. Through subsidies, which lower the price for private sales or purchases of goods that are underproduced.

The Four Questions of Public Finance

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How Might the Government Intervene?

Restrict or Mandate Private Sale or Purchase


Public Provision

The government can directly restrict the private sale or purchase of goods that are overproduced, or mandate the private purchase of goods that are underproduced and force individuals to buy that good.

The government can provide the good directly, in order to potentially attain the level of consumption that maximizes social welfare.

Public Financing of Private Provision

Governments may want to influence the level of consumption but may not want to directly involve themselves in the provision of a good.

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What Are the Effects of Alternative Interventions?

Direct Effects


direct effects The effects ofgovernment interventions thatwould be predicted if individualsdid not change their behavior inresponse to the interventions.

Indirect Effects

indirect effects The effects ofgovernment interventions thatarise only because individualschange their behavior inresponse to the interventions.

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The Congressional Budget Office: Government Scorekeepers

A P P L I C A T I O N

The methods and results derived from empirical economicsare central to the development of public policy at all levelsof government.

The Congressional Budget Office (CBO) provides Congress with the objective, timely, nonpartisan analyses needed for economic and budget decisions.

The CBO increasingly plays a critical role as a “scorekeeper” for government policy debates.

Legislative spending proposals that are to become law must first have their costs estimated by the analysts at the CBO.

It is not an overstatement to say that the economists who work at the CBO frequently hold the fate of a legislative proposal in their hands. The large price tag that the CBO assigned to the Clinton administration’s plan to reform health care in the United States in 1994 is often cited as a key factor in the defeat of that proposal.

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Why Do Governments Do What They Do?


political economy The theoryof how the political process produces decisions that affect individuals and the economy.

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The Size and Growth of Government

1 . 2Why Study Public Finance? Facts on Government in the United States and Around the World

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The Size and Growth of Government


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Spending, Taxes, Deficits, and Debts


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Decentralization


A key feature of governments is the degree of centralization across local and national government units—that is, the extent to which spending is concentrated at higher (federal) levels or lower (state and local) levels.

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Distribution of Spending


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public goods Goods for whichthe investment of any one individual benefits everyone in alarger group.

social insurance programsGovernment provision of insurance against adverse events to address failures in the privateinsurance market.

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Distribution of Revenue Sources


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Distribution of Revenue Sources


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Regulatory Role of the Government


Another critical role the government plays in all nations is that of regulating economic and social activities.

The Food and Drug Administration (FDA) regulates the labeling and safety of nearly all food products and bottled water, tests cosmetics to ensure their safety, and approves drugs and medical devices to be sold to the public.

The Occupational Safety and Health Administration (OSHA) is charged with regulating the workplace safety of the 115 million Americans employed at 7.2 million job sites.

The Federal Communications Commission (FCC) regulates interstate and international communications by radio, television, wire, satellite, and cable.

The Environmental Protection Agency (EPA) is charged with minimizing dangerous pollutants in the air, water, and food supplies.

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Social Security

1 . 3

Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education

Social Security is the single largest government expenditure program. The financing structure of this program is basically that today’s young workers pay the retirement benefits of today’s old.

Health Care

There are currently 45.8 million Americans without any health insurance, about 18% of the non-elderly U.S. population. Projections suggest that health care will consume almost half of our GDP within the next century.

Social Security, health care, and education are each the subject of debate, with both the “liberal” and “conservative” positions holding differing views in their approach to each problem.

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Education

1 . 3Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education

There is an enormous dissatisfaction with our current educational system, highlighted by the dismal performance of U.S. students on international tests.

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1 . 4Conclusion

It is clear from the facts presented here that the government plays a central role in the lives of all Americans.

It is also clear that there is ongoing disagreement about whether that role should expand, stay the same, or contract.

The facts and arguments raised in this chapter provide a backdrop for thinking about the set of public finance issues that we explore in the remainder of this book.

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The Size of Government

How to measure the size of governmentNumber of workersAnnual expenditures

Types of government expenditurePurchases of goods and servicesTransfers of incomeInterest payments

Budget documentsUnified budgetRegulatory budget

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