Public Finance and Public Policy

Public Finance and Public Policy Jonathan Gruber Third Edition Copyright © 2010 Worth Publishers 1 of 24

Why Study

Public Finance?

1.1 The Four Questions of

Public Finance

1.2 Why Study Public

Finance? Facts on

Government in the United

States and around the World

1.3 Why Study Public

Finance Now? Policy Debates

over Social Security, Health

Care, and Education

1.4 Conclusion

Public Finance and Public Policy Jonathan Gruber Third Edition Copyright © 2010 Worth Publishers

C H A P T E R 1 ■ W H Y S T U D Y P U B L I C E C O N O M I C S ?

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When Should the Government Intervene in the Economy?

The Four Questions of Public Finance

1.1

market failure Problem that

causes the market economy to

deliver an outcome that does

not maximize efficiency.

Market Failures



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1.1

APPLICATION

The Measles Epidemic of 1989–1991

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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When Should the Government Intervene in the Economy?


1.1

redistribution The shifting

of resources from some

groups in society to others.

Redistribution



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How Might the Government Intervene?


1.1

Tax or Subsidize Private Sale or Purchase

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.



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How Might the Government Intervene?


1.1

Restrict or Mandate Private Sale or Purchase

The government can directly restrict private sale or purchase of goods

that are overproduced, or mandate private purchase of goods that are

underproduced and force individuals to buy that good.

Public Provision

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 of

government interventions that

would be predicted if individuals

did not change their behavior in

response to the interventions.

Indirect Effects

indirect effects The effects of

government interventions that

arise only because individuals

change their behavior in

response to the interventions.

1.1




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The Congressional Budget Office:

Government Scorekeepers

The methods and results derived from empirical economics

are central to the development of public policy at all levels

of 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.

1.1


APPLICATION



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Why Do Governments Do What They Do?

political economy The theory

of how the political process

produces decisions that affect

individuals and the economy.

1.1




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The Legal Framework

Federal government

Federal Constitutional provisionsArticle 1, Section 8 —provide for general welfare

Article 1, Section 9 -fair tax, interstate commerce

16th Amendment –income tax

5th Amendment –reasonable in power of eminent domain



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The Legal Framework

State governments

Federal constitutional provisions10th amendment -state get whatever Feds don’t spell out

The State constitutions –fiscal power

Local governments

Derive power to tax and spend from the States

Fiscal independence of local governments



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The Size and Growth of Government

1.2

Why Study Public Finance? Facts on Government in the

United States and around the World



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The Size and Growth of Government

1.2





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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.

1.2



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Spending, Taxes,

Deficits, and Debts



1.2

Federal Revenues and

Expenditures, Surplus or

Deficit, and Debt, 1930–2008 •

For most of the twentieth century,

except for the World War II

period, federal government tax

receipts have kept pace with

expenditures. But expenditures

have exceeded receipts by

several percentage points of

GDP on average since the

1970s. The resulting federal

government debt is now at about

40% of GDP.

Source: Office of Management and Budget

(2008), Tables 1.2 and 7.1. (Debt figures for

1930–1939 come from the U.S. Department of

the Treasury’s Bureau of the Public Debt.)



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Spending, Taxes, Deficits, and Debts



1.2



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Spending, Taxes, Deficits, and Debts



1.2



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Distribution of Spending



1.2

The Distribution of Federal

and State Expenditures,

1960 and 2007 • This figure

shows the changing

composition of federal and

state spending over time, as

a share of total spending. (a)

For the federal government,

defense spending has fallen

and Social Security and

health spending have risen.

(b) For the states, the

distribution has been more

constant, with a small decline

in education and welfare

spending and a rise in health

spending.

Source: Bureau of Economic Analysis,

NIPA Table 3.16.



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Distribution of Spending



public goods Goods for

which the investment of any

one individual benefits

everyone in a larger group.

social insurance programs

Government provision of

insurance against adverse

events to address failures in

the private insurance market.

1.2



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Distribution of Revenue Sources



1.2

The Distribution of Federal and

State Revenues, 1960 and 2008 •

This figure shows the changing

composition of federal and state

revenue sources over time, as a

share of total revenues. (a) At the

federal level, there has been a

large reduction in corporate and

excise tax revenues and a rise in

payroll tax revenues. (b) For the

states, there has been a decline in

property taxes and a rise in income

taxes and federal grants.

Source: Bureau of Economic Analysis, NIPA

Tables 3.2 and 3.3.



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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 135 million

Americans employed at 8.9 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.

1.2



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Social Security

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 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 these major policy issues.

1.3



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Education

Why 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.

1.3



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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.

1.4

Conclusion

Public Finance and Public Policy

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