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Chapter 1 - Introduction

Public Economics

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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 economic sphere?

• Organic view – community stressed above individual. Goals of society set by the state.

• 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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Government at a Glance

• Legal framework

– Federal government• No real constraints on spending in Constitution

• Taxes must come originate in House of Representatives.– Equal tax rates across states.– Income tax came from 16th amendment to Constitution.

• Can run budget deficits

– State and local government• Can impose spending / taxing restrictions on itself.

• Many states cannot run budget deficits.

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Government at a Glance

• Size of government – how to measure?– Number of government employees

– Annual expenditures• Purchases of goods and services, transfers,

and interest payments

• Unified budget – In 2001, $1.6 trillion spent at federal level, and another $1.3 trillion at state and local levels.

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Government at a Glance

• These numbers ignore activities that do not have explicit outlays, but substantial effects on resource allocation.

– Regulations, for example.

– Conceivably, could construct a “regulatory budget” to account for these costs, but difficult to compute.

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Government Expenditure

• Some numbers

• Annual expenditures have grown by a factor of 290 from 1929-2001.

– Inflation, population also changing. Real, per-capita expenditure still 10 times as large.

– As percentage of GDP, government expenditure was 9.6% in 1929, and 29.3% in 2001.

Table 1.1

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Government Expenditure

• United States versus other developed countries.

• U.S. public sector is quite small compared to Sweden or France, and smaller than all the countries listed.

• Although large, the U.S. government is small in relative terms. More reliance on private sector.

Table 1.2

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Government Expenditure

• In 1965

• National defense almost half of federal expenditure

• Social security small & Medicare non-existent

• Debt payments roughly constant.

• In 2001

• Defense was less than one-fifth

• Social security now largest spending item, Medicare large & growing

Figure 1.1

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Government Expenditure

• Much of the government budget consists of entitlement programs – programs with costs determined by number of people who qualify.

– Social Security, Medicare, welfare

• Three-quarters of the federal budget is relatively uncontrollable, because of these entitlements.

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Government Expenditure

• Federal government responsible for about 51% of direct expenditure.

• State governments responsible for 21%.

• Local governments responsible for 28%.

– State & local governments primarily responsible for police & fire protection, education, transportation, and some welfare programs.

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Government Revenues

• Federal taxes mainly consist of individual income taxes, payroll taxes, and corporate taxes.– Personal income tax 46% of collections.

• State & local taxes mainly consist of property taxes, sales taxes, individual income taxes, and grants from federal government.– Less reliance now on property tax, more on income

tax.

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Recap of Introduction

• Public finance, definition

• Views of government

• Government expenditure

• Government revenue