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CHAPTER 22

CHAPTER 22. PUBLIC FINANCE IN A FEDERAL SYSTEM. Background. Federal system Fiscal federalism Centralization Centralization ratio = Central government expenditures Total government expenditures. Community Formation.

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CHAPTER 22

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  1. CHAPTER 22 PUBLIC FINANCE IN A FEDERAL SYSTEM

  2. Background • Federal system • Fiscal federalism • Centralization • Centralization ratio = Central government expendituresTotal government expenditures

  3. Community Formation • Club – voluntary association of people who band together to finance and share some benefit • Optimal Club (or community)

  4. The Tiebout Model • Voting with your feet • Tiebout’s assumptions • Government activities generate no externalities • Individuals are completely mobile • People have perfect information with respect to each community’s public services and taxes • There are enough different communities so that each individual can find one with public services meeting her demands • The cost per unit of public services is constant so that if the quantity of public services doubles, the total cost also doubles • Public services are financed by a proportional property tax • Communities can enact exclusionary zoning laws—statutes that prohibit certain uses of land

  5. Tiebout and the Real World • Critique of Tiebout • Empirical tests

  6. Optimal Federalism • Macroeconomic functions • Microeconomic functions

  7. Disadvantages of a Decentralized System • Efficiency issues • Externalities • local public good • Scale economies in provision of public goods • Inefficient tax systems • Scale economies in tax collection • Equity issues

  8. Advantages of a Decentralized System • Tailoring outputs to local taxes • Fostering intergovernmental competition • Experimentation and information in locally provided goods and services

  9. Implications • Purely decentralized systems cannot maximize social welfare • Dealing with community activities that create spillover effects that are not national in scope • Combine communities under a single regional government • Pigouvian taxes and subsidies • Division of responsibility in public good provision • Distributional goals and mobility

  10. Public Education in a Federal System • Local control of schools • Financing education through property taxation • Federal role in education

  11. Property Tax Residential Property Tax Rates (selected cities) • How the property tax works • Assessed value • Assessment ratio

  12. Incidence and Efficiency Effects – The Traditional View - Tax on Land SL Rent per acre of land Price received by landowners falls by amount of the tax PsL = P0L P0L PnL DL DL’ Acres of land

  13. Incidence and Efficiency Effects – The Traditional View - Tax on Land • Tax capitalized into price of land • Land not fixed in supply

  14. Incidence and Efficiency Effects – The Traditional View - Tax on Structures Price paid by tenants increases by full amount of the tax Price per structure PgB SB P0B PnB = P0B PnL DB DB’ B1 B0 Number of structuresper year

  15. Summary and Implications of the Traditional View • Progressivity • Land tax • Structures tax • Empirical evidence • Measuring income

  16. The New View: Property Tax as a Capital Tax • Partial equilibrium versus general equilibrium • General Tax effect • Excise Tax effects • Long-run effects

  17. Property Tax as a User Fee • The notion of the incidence of the property tax is meaningless • The property tax creates no excess burden • Federal income tax subsidizes consumption of local public services for individuals who itemize • Oates [1969]

  18. Reconciling the Three Views • New view: Eliminating all property taxes and replacing them with a national sales tax • Traditional view: Lowering property tax rate and making up revenue from local sales tax • User fee view: Taxes and benefits jointly changed and people are sufficiently mobile

  19. Why Do People Hate the Property Tax So Much? • Property tax levied on estimated value • Property tax highly visible • Property tax perceived as being regressive • Circuit breakers • Property tax easier to attack

  20. Ideas for Improving the Property Tax • Improve assessment procedures • Personal net worth tax

  21. Intergovernmental Grants Relation of federal grants-in-aid to federal and state-local expenditures (selected fiscal years)

  22. Why Have Intergovernmental Grants Grown So Much? • Mismatch theory

  23. Conditional (Categorical) Grants Matching Grants Consumption (c) per year A E2 c2 E1 c1 G1 G2 B R Units of public good (G) per year

  24. Conditional (Categorical) Grants Matching Closed-Ended Grants Consumption (c) per year A E3 D c3 E1 c1 G1 G3 B R Units of public good (G) per year

  25. Conditional (Categorical) Grants Nonmatching Grants Consumption (c) per year J H A E4 c4 E1 c1 G1 G2 B R Units of public good (G) per year

  26. Unconditional Grants • Revenue sharing • Measuring Need • Tax effort

  27. The Flypaper Effect • Whose indifference curves? • Median voter theorem • Flypaper effect

  28. Intergovernmental Grants for Education • Serrano v Priest [1971] • Foundation aid • District power equalization grants • Issues • Educational outcomes • Impact of centralized financing on voters’ support for public education

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