Why Study Public Finance?

1. Why Study Public Finance? Econ 344 Public Finance Prof. Daniel OttoChapter 1 - Introduction

2. Public Finance

8. Public financeis 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 wide-ranging – government has role in many activities, but focus will be on taxes and spending. Public Finance Defined

9. 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 traditional viewpoint taken by modern public finance. Public Finance and Ideology

10. Federal government Federal Constitutional provisions Article 1, Section 8 Article 1, Section 9 16th Amendment 5th Amendment The Legal Framework

11. State governments Federal constitutional provisions 10th amendment The State constitutions Local governments Derive power to tax and spend from the States Fiscal independence of local governments The Legal Framework

12. 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. 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

13. The Four Questions of Public Finance 1 . 1 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?

14. 1 . 1 The Four Questions of Public Finance A. When Should the Government Intervene in the Economy? Market Failures market failure Problem that causes the market economy to deliver an outcome that does not maximize efficiency.

15. 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.

16. 1 . 1 The Four Questions of Public Finance A. When Should the Government Intervene in the Economy? Redistribution redistribution The shifting of resources from some groups in society to others.

17. 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. 1 . 1 The Four Questions of Public Finance B. How Might the Government Intervene? Tax or Subsidize Private Sale or Purchase

18. 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. 1 . 1 The Four Questions of Public Finance How Might the Government Intervene? Restrict or Mandate Private Sale or Purchase 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.

19. 1 . 1 The Four Questions of Public Finance C. 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.

20. The Congressional Budget Office: Government Scorekeepers • 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.

21. 1 . 1 The Four Questions of Public Finance D. Why Do Governments Do What They Do? political economy The theory of how the political process produces decisions that affect individuals and the economy.

22. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Spending, Taxes, Deficits, and Debts

24. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World The Size and Growth of Government

25. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Spending, Taxes, Deficits, and Debts

27. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Spending, Taxes, Deficits, and Debts

28. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Spending, Taxes, Deficits, and Debts

29. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World State and Local Spending, Taxes, Deficits, and Debts

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

31. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Distribution of Spending

32. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Distribution of Spending---Federal and State

33. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World 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.

34. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Distribution of Revenue Sources

35. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Distribution of Revenue Sources---State/local

36. Another critical role the government plays in all nations is that of regulating economic and social activities. 1 . 2 Why Study Public Finance? Facts on Government in the United States and Around the World Regulatory Role of the Government • 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.

37. 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. 1 . 3 Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education 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. Social Security 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.

38. There is an enormous dissatisfaction with our current educational system, highlighted by the dismal performance of U.S. students on international tests. 1 . 3 Why Study Public Finance Now? Policy Debates over Social Security, Health Care, and Education Education

39. 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