Chapter 1 - Introduction Public Economics

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.

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.

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.

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.

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.

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

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

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

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.

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.

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.

Recap of Introduction Public finance, definition Views of government Government expenditure Government revenue